Essential Utilities, Inc. — Q2 2020 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2020. Unaudited; financial amounts below are in millions of dollars except per-share data. Essential Utilities provides regulated water and wastewater services and, following its March 16 acquisition of Peoples Natural Gas, regulated natural gas distribution.
Financial performance and position
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Operating revenue | $384.5 | $218.9 | $640.1 | $420.0 |
| Operating income | $123.1 | $80.9 | $196.6 | $148.4 |
| Net income | $74.6 | $54.9 | $126.4 | $71.8 |
| Diluted EPS | $0.29 | $0.25 | $0.50 | $0.36 |
| Operating cash flow | — | — | $245.2 | $87.5 |
Q2 operating margin was approximately 32.0%, versus 37.0% in Q2 2019; net margin was approximately 19.4%, versus 25.1%. These are calculated from reported figures and reflect a changed business mix as well as acquisition-related costs. Six-month capital expenditures were $293.1 million, exceeding operating cash flow by approximately $47.9 million before acquisitions and financing.
At June 30, cash was $7.2 million, compared with $1,868.9 million at year-end 2019; the earlier balance included acquisition financing held pending the Peoples closing. Long-term debt was $5,301.2 million gross, versus $3,077.4 million at December 31, 2019. Current assets of $312.5 million were below current liabilities of $448.2 million. The company reported $956.1 million available under its $1.0 billion revolving facility and $120.5 million available on short-term credit lines.
Peoples contributed $188.2 million of revenue and $31.8 million of earnings from acquisition through June 30. Its Q2 natural gas segment reported $105.3 million of gross margin, a non-GAAP measure, and $24.7 million of operating income.
Changes versus prior period
- Q2 revenue rose $165.6 million, or 75.6%; six-month revenue rose $220.0 million, or 52.4%. The principal driver was the Peoples acquisition, which contributed $149.6 million of Q2 natural gas revenue and $188.2 million for the six-month period from closing.
- Six-month net income increased $54.6 million. Results also benefited from the absence of 2019 debt-extinguishment and interest-rate-swap charges; comparisons are affected by acquisition timing and financing.
- Operating costs increased with the added gas business, including purchased gas, depreciation, and interest. Water and wastewater rate increases and customer growth also supported revenue.
- Weighted-average diluted shares increased to 254.5 million for the first half from 199.3 million, including shares issued to finance the acquisition.
Outlook, risks and unusual items
- Outlook: No specific earnings or revenue guidance is provided. Management said internally generated funds, credit facilities, and access to debt and equity markets should provide adequate working capital for at least the next 12 months. It expected to continue its capital investment program.
- COVID-19: Management did not anticipate a significant financial impact at the time of filing, but noted increased residential usage, reduced commercial and industrial usage, collection constraints, potential customer payment difficulties, additional costs, and uncertainty around supply chains and regulatory approvals. Six-month COVID-related expenses included bad debt and protective supplies; impacts could change as the pandemic evolves.
- Acquisition and financing: Peoples was acquired for $3,465.3 million cash consideration, with the purchase-price allocation still preliminary and expected to be finalized by Q1 2021. A dispute remained over a purchase-price adjustment for seller capital expenditures. The acquisition added $2,269.4 million of goodwill, not expected to be tax deductible. The company issued $1.1 billion of long-term debt in April and Aqua Pennsylvania issued $175 million of bonds in May.
- Regulatory commitments: The company committed to replace gathering pipe over seven years at an estimated cost of $120 million, recoverable through rates, and provide $23 million in customer rate credits by year-end 2020.
- Tax: Flow-through deductions for qualifying infrastructure investments reduced income tax expense by $11.2 million for the six months. The effective tax rate was negative 5.6% for the first half; the company was still assessing the related tax adjustment.
- Contingencies and pending acquisitions: Accrued loss contingencies were $21.6 million, with approximately $9.1 million estimated recoverable through insurance. A water-quality advisory and related Illinois class-action case remained under assessment; class certification had not been granted, and no liability was accrued for possible future fines or penalties. The proposed DELCORA acquisition remained subject to regulatory approval and litigation challenging the customer trust funding; closing was expected in early 2021, subject to those matters. New Garden Township acquisition closing was expected in Q4 2020, subject to approvals.
- Other risks: The filing highlights pandemic effects, regulation, weather, capital-market access, acquisition integration and valuation, and competition or customer bypass in natural gas. Management reported disclosure controls effective; integration of Peoples’ financial controls was ongoing.
Investor verification priorities
- Track final Peoples purchase-price adjustments and purchase accounting, including goodwill and acquired liabilities.
- Monitor leverage, refinancing needs, revolver availability, and cash generation relative to capital spending and acquisition plans.
- Verify delivery and accounting for the $23 million customer credits and progress and rate recovery for the gathering-pipe replacement commitment.
- Follow COVID-related collections, bad debt, deferred costs, and changes in customer usage or regulatory restrictions.
- Check developments in the Illinois water-quality matter and DELCORA litigation and regulatory approvals.
- Assess the sustainability of reported earnings in light of acquisition timing, tax benefits, transaction costs, and higher share count.